Indonesia’s economy is moving at a moderate pace in the midst of uncertainty due to the impending rate hike by the Fed, along with weakness in China. Though exports have been weak, key components of the economy, such as private consumption, seem to be in place.

The world economy is going through some nervous moments. Uncertainty over the impact of an impending rate hike by the US Federal Reserve (Fed), along with weak economic data from key emerging markets like China are keeping policymakers and investors on their toes. In this climate, Indonesia’s economy appears to be moving along at a moderate pace. Key components of the economy, such as private consumption, appear to be on relatively stable ground. Exports, however, have been a headache this year, primarily due to subdued global commodity markets. This, yet again, calls for urgent reforms to diversify the economy by easing regulations, encouraging small and medium enterprises (SMEs), boosting infrastructure, and creating a vibrant education system.

While President Jokowi’s attempts to attract foreign investments and develop manufacturing are appreciated, people will be looking more at economic growth and job creation. Without strong improvements in the labor market, consumers will likely hold on to their wallets.

GDP expands at a modest pace in Q3

Indonesia’s economy grew 4.7 percent year over year in Q3, more or less the same as the previous quarter. Growth picked up across expenditure segments, except for exports (see figure 1). Private consumption was again a key growth driver in Q3, expanding by 5.0 percent. Although the figure is lower than in 2010–12, consumers appear to be benefitting from an expansion of social welfare schemes and expectations of a decline in inflation next year.

Fixed investments also picked up pace in Q3 (4.6 percent) from Q2 (3.7 percent). However, this is not enough to raise GDP growth to President Jokowi’s 7 percent target when he took office in 2014. Nevertheless, an uptick in Q3 is encouraging, especially as the government tries to spend more on infrastructure in the near term. Government consumption expanded 6.6 percent, up from 2.1 percent in Q2, providing much-needed relief to the economy in the face of declining exports.

Commodities are weighing on Indonesian exports

Exports fell for the fourth straight quarter in Q3, contracting 0.7 percent. This was worse than the 0.1 percent fall in Q2. The declining fortunes of exports owe much to fluctuations in global commodity markets. Indonesia is a key commodity exporter; almost a third of Indonesia’s goods exports this year are commodities. Asia is a major export destination, with China being a key market within the region. For example, Asia and the Middle East account for two-thirds of Indonesia’s goods exports.

Sadly, slowing growth in China and other key emerging markets have weighed on both prices and demand. Consequently, commodity producers like Indonesia have seen export revenues decline (see figures 2 and 3). This is also reflected in the falling share of commodities in the total exports this year (from more than 50 percent in January to less than 30 percent in October). This in turn has dented GDP growth. For example, real growth in mining and quarrying has been in negative territory for the first three quarters this year (see figure 4).

Consumers, however, will continue to lend strength to the economy

Amid a weak external sector, Indonesia’s economy will continue to rely on domestic consumers. Consumers are likely to benefit from declining inflation in the coming months, especially with the impact of fuel subsidy cuts likely to fizzle out in early 2016. This will boost real incomes. In addition, Bank Indonesia’s (BI’s) focus on inflation is starting to give results. Inflation slowed down in October to 6.3 percent year over year from 6.8 percent in September (see figure 5).

Consumers, however, appear wary of slowing economic growth. While President Jokowi’s attempts to attract foreign investments and develop manufacturing are appreciated, people will be looking more at economic growth and job creation. Without strong improvements in the labor market, consumers will likely hold on to their wallets. In Q3, unemployment (non-seasonally adjusted) actually went up to 6.2 percent from 5.8 percent in Q2. Consumers’ weariness is already being felt, with retail sales slowing down, even as consumer confidence fell into negative territory in September (see figure 6).

BI will be wary of external events

While inflation appears to be inching down, the central bank also has its eyes fixed on a weakening rupiah (down 9.3 percent against the US dollar this year). BI will be worried about any further impact on the currency due to a Fed rate hike. What has also weighed on emerging market currencies is China’s currency strategy. The rupiah lost 3.9 percent against the US dollar in August, mainly due to the yuan’s devaluation (see figure 7).

Short-term instability in global financial markets will continue. In fact, markets are already keeping an eye on economic data from China and monetary policy developments in the Eurozone. This will keep BI on its toes, and it is not likely to ease monetary policy in the next two to three quarters. In its November meeting, BI kept its key policy rate on hold for the ninth straight month, although it cut the reserve requirement by 50 basis points to stimulate domestic demand. For now, the central bank can draw some comfort from an improvement in the current account deficit (non-seasonally adjusted) to -1.9 percent of GDP in Q3 2015 from a high of -4.3 percent in Q2 2014.

It’s over to you, fiscal

In such a scenario, any stimulus to domestic demand will have to come from the fiscal side. After a low-key first half of 2015, the government introduced a slew of stimulus measures, including incentives for investments in special economic zones, labor market changes, and ease of doing business for SMEs. Also, the government appears to be pushing ahead with its infrastructure agenda after initial delays; its budget for 2016 includes an 8 percent hike in infrastructure spending. This is likely to aid fixed investment and GDP growth in the coming quarters. Hearteningly, Jokowi appears to be changing gears despite political pressures. Changes to his cabinet in August and efforts to include more technocrats are steps in the right direction. But, he has to do more to match action with intent. It could just be the boost that the economy needs to overcome external volatilities and to take advantage of greater economic integration in the region.